State Policies Created School Pension Pain

The only real solution is to close public pensions to new employees

Pension costs are forcing tough choices on Michigan’s school districts. Their problems are caused almost entirely by state policies, so the solution must come from the state.

In Michigan, school districts have little to say about the retirement benefits offered to their employees; all the key decisions are set by state policy. The state requires districts to use its retirement system, sets its benefits, and decides what the funding assumptions and policies will be. To pay for pension benefits, the state assesses districts a percentage of their payroll. A district sends 36.31 percent of its payroll to the school pension system, while the employees, as a group, must put 4.69 percent of their paychecks in the system.

State officials made some basic reforms in 2012 as more and more school districts began to grapple with the budget implications of retirement benefits. That year, the state said it would cap school districts’ annual responsibility for pensions. It also announced that it would begin sending an extra payment to the districts to cover a portion of pension benefits. Currently, that’s 10.53 percent of payroll, for a total of $1.082 billion for the 2016-17 fiscal year. This additional funding to districts accounts for $1 out of every $11 the state spends on K-12 education.

If the state weren’t making these payments, it could use that same amount of money to increase the foundation allowance by $727 per pupil. Conversely, if the state didn’t make those payments, districts would have to dip further into their foundation allowance to meet pension commitments.

Public attention often focuses on the size of the foundation allowance. But public school districts would rather see extra money from the state go to cover pension costs than increase the foundation allowance, an unrestricted grant. The reason is that charter schools do not participate in the public school pension system and therefore do not receive the state pension assistance; they would, however, receive their share of an increased foundation allowance, and districts would receive less.

Charter school employees generally work for a charter management company and are not part of the school retirement system that is mandatory for public school employees. Few charters would want to join the public pension plan, since private sector retirement plans tend to cost much less than the burden currently shouldered by school districts — typically 5 percent to 7 percent of payroll compared to 20.96 percent.

While the difference in retirement costs is often pointed to as a structural advantage for charter public schools, districts have advantages of their own. For instance, districts can put additional millages in front of voters to cover construction costs for new or upgraded school buildings, while charters do not have access to that funding source.

The massive scope of the pension problem has led a variety of stakeholders to propose solutions. Some of those are worthwhile, while others create new problems.

One concept regularly floated by some public school proponents is to force charter schools to contribute toward paying down the pension underfunding that plagues the statewide school retirement system. The idea is based on the belief that pension shortfalls were caused in part by decreased payrolls in public school districts brought on by the growth of charter schools. But the issue is not the size of the payroll in the statewide retirement system. Instead, it’s the size of the unfunded liabilities. Spreading the cost of catching up on underfunding to a larger base does not dilute the cost.

Moreover, Michigan’s teacher pension system would be in even worse shape if it had covered employees at public charter schools. It would also be unfair since charters would be cleaning up a mess they had no hand in creating.

Another questionable model for dealing with the pension system’s underfunding also involves spreading burden over a larger base, in this case, by levying an assessment on services purchased by both districts and charter schools. Each year, schools increasingly contract out for support services. Contractors have a competitive advantage over in-house employees since districts don’t have to pay into the state retirement system for contract employees. Some officials think the growth of contracting harms the retirement system, so they propose an assessment. But that is no solution. While an assessment would encourage districts to bring services back in house, doing so would expose both districts and the retirement system to even more unfunded liabilities.

All the discussions of what to do about pension underfunding are overshadowed by a major issue: Lawmakers cannot be counted upon to keep their spending promises. It is difficult to bind lawmakers to giving money in the future, outside of a constitutional requirement. The cap language is just a statute that lawmakers can change at will, and specific funding amounts still have to be agreed upon through the appropriations process. So far, Michigan’s policymakers have been reasonably effective at fully funding to the cap. In fact, they have often given more money than is required, which frees up district spending on other areas.

But school district officials have no guarantee that this pattern will continue. Future legislators could change the statute that places a cap on what districts must send to the pension system. They could do it with no more votes than would be required to pass annual budget appropriations bills.

Some people argue that the money going to these benefits does not make its way into the classroom, but that does not reflect the reality of how school funding works. Teachers’ retirement costs are part of employee compensation, and if there’s anything that should be considered as spending “in the classroom,” it’s the compensation of the teachers in those rooms. It is true that 87 percent of pension costs are going to benefits that employees have already earned, rather than compensating teachers for the work they do today. But that simply means we’re still spending for yesterday’s classrooms today because we didn’t spend what we should have at the time.

The pension underfunding problem is the largest long-term issue facing Michigan. State policymakers made overly optimistic assumptions about what pensions cost and have not set aside enough money to pay what they promised. Until this problem gets fixed, any additional money being generated by sales taxes, income taxes and property taxes for schools may wind up in the pension system.

The underfunding albatross has been getting larger every year. The state’s payments to districts do help them out and limit their exposure to the pension burden. But they do not absolve lawmakers of their responsibility to properly fund a pension system that meets the commitments the state has made to current and former employees. Nor do they fix the system’s funding problem. To stop the underfunding, lawmakers ought to develop a defined contribution system that will put teachers’ future retirements in their own hands rather than at the mercies of the annual appropriations process.